Of all the issues that have bedeviled
regulators and legislators dealing with consumer protection, perhaps the
most troublesome have been abuses connected to mortgage loan originator
compensation. Most reform proposals have been directed to abuses by
mortgage brokers, and don’t apply to loan officer employees of lenders.
And many of the less thoughtful proposals for curbing broker abuses
would eliminate the borrower’s option to have the lender pay the
broker’s fee in exchange for a higher rate.
Objectives of Compensation Rules
I am pleased to report that the recent
proposals of the Federal Reserve to amend the Truth in Lending Act
(TILA) deals with abuses by loan officers as well as brokers. In
addition, the revised TILA would retain the option borrowers now have in
how they pay mortgage brokers.
Loan originators (henceforth LOs) are
those individuals who deal directly with borrowers. The problem is not
how much LOs make, but how they make it. Under existing arrangements,
LOs can often increase their income by inducing borrowers to make bad
choices. This works because most borrowers don’t have the information
and education needed to protect themselves. Many LOs don’t succumb to
this temptation, but too many do.
Curbing Abuses by Mortgage Brokers
The abusive tactic that has generated the
most attention, as well as controversy, centers on payments to brokers
by wholesale lenders for delivering interest rates that are higher than
the “par rate” – the rate at zero points. For example, a lender
delivering prices to a broker who quotes 5% on a 30-year FRM at zero
points might pay 1 point for 5.25%, or 2 points for 5.5%. (A point is 1%
of the loan amount). These payments by a lender are called “rebates”, or
“negative points”. When pocketed by a mortgage broker, they are called
“yield spread premiums” or YSPs.
There is nothing inherently abusive about
YSPs -- quite the contrary, when properly used they provide a valuable
option to borrowers. But they can and are used abusively. Here are
illustrations of proper use by an ethical broker, and abusive use by a
deceitful one.
Ethical Broker: Mrs. Jones, my fee is 1
point. If you select the 5% loan, you will pay me at closing. As an
alternative, you can take the 5.25% loan and the lender will pay my 1%
fee.
Deceitful Broker: Mrs. Jones, your rate
is 5.50%. The good news is that my fee is being paid by the lender so my
services to you are free.
Upfront Mortgage Brokers (see
www.upfrontmortgagebrokers.org) follow the first model, disclosing
their fee to the borrower while explaining how the fee is related to the
interest rate. Deceitful brokers don’t explain this, because the
borrower’s ignorance allows the broker to charge more, as in my example.
Loan officers who work for a single
lender can also be abusive, but in a different way. These LOs receive
retail prices from their back offices, meaning that the LO’s commission
is included in the posted price. But the LO typically has discretion to
charge the borrower more than the posted price, termed an “overage”, if
he can get the borrower to accept it. The LO shares the overage with the
firm. Overage abuse has attracted much less attention than YSP abuse,
but there is no reason to believe it is less pervasive.
The Fed proposes to prohibit payments to
mortgage brokers and to LO employees of lenders that are based on a
loan’s “terms and conditions,” which include the interest rate and
points. This rule will bar a wholesale lender from paying a broker more
for a loan with a higher interest rate than for the same loan with a
lower rate. However, the rule will not prohibit lenders from offering
rebates on loans with above-par rates, which brokers could offer to
clients to cover their fee and/or other settlement costs.
A rigidity in these rules is that a
broker must be paid entirely by the borrower or entirely by the lender;
he cannot be paid by both. The rationale is that borrowers may get
confused if the broker fee is shared by the two parties.
Curbing Abuses by Loan Offiers
The Fed’s proposed rule would also bar
lenders from offering higher commissions on loans carrying overages. It
doesn’t bar overages, but it removes all financial incentives for the
originator to charge one. This undercuts the allegation of the National
Association of Mortgage Brokers (NAMB) that efforts to rein in YSP abuse
alone would create an “unequal playing field.”
I don’t know whether or not NAMB will
sign off on the Fed’s proposed rules, but the proposals create no
problem for the smaller Upfront Mortgage Brokers Association (UMBA),
whose members are already in full compliance. By removing a major source
of ambiguity regarding how much the borrower is paying the broker, these
rules will bring the industry closer to the UMBA standard of complete
fee disclosure.
Note: Thanks to Chris Cruise for helpful
suggestions.